Greece, brinkmanship and the euro, again

A few months ago, Jacob Kirkegaard was congratulating the EU’s northern member states for having discovered how awesome brinkmanship was as a mode of bargaining over Greek policy reforms. As I noted then, brinkmanship, contra Kirkegaard, is a terrible way of making policy. It only works to the extent that the threat of catastrophe for all involved is a real one. And, to the extent that the threat of catastrophe is real, bluffing and seeking to constrain oneself in ways that will oblige the other side to do what you want them to do (Schelling’s definition of strategy), may work out very badly indeed. If you’ve miscalculated, both you and the other side may find yourselves in deep, deep trouble. To quote Branislav Slantchev yet again

Obviously, these are very dangerous tactics; they would not work unless they were dangerous because it is the generation of risk that makes them potentially worthwhile.

A weaker version of this critique applies to Matthew Yglesias’ more recent take on Grexit.

a short-term departure is much less likely than the hype would lead you to believe. Everyone has big incentives to bluff right now, but if Greece does end up leaving the euro it’ll happen later as part of a broader and more comprehensive split. … there’s an excellent chance that everyone is bluffing. Tsipras is a bit like a person who’s wandered into a rich guy’s living room and is threatening to shoot himself in the head unless the rich guy hands over some cash. It’s not a very credible threat … On the other hand, it might make sense for the rich guy to pay up. Brains splattered all over the carpet and furniture might be more expensive to clean than just paying the guy to go away. … In the case of the eurozone, the carpet and furniture are Portugal, Ireland, and Spain. Once it becomes clear that an exit from the euro is a real possibility, the odds are that people who hold bank accounts in those countries will want to take their money out.
The point is that while Germany would obviously prefer not to offer Greece more generous terms, there’s good reason to think that they’d be willing to do it. By the same token, it makes sense for Greece to ask. In essence, the situation is fertile territory for bluffing. Tsipras pretends it makes sense for Greece to demand a better deal, and Angela Merkel pretends it makes sense to let Germany walk away from the euro. This game of chicken might end up badly, but the frantic press reports are mostly a reflection of the bluffs not the actual likelihood of Greece leaving.

The final sentences of this post are absolutely correct – press reports do underplay the extent to which both Greece and Germany are engaged in bluffing and brinkmanship. But this doesn’t sit at all well with the claim that “if Greece does end up leaving the euro it’ll happen later as part of a broader and more comprehensive split.” It’s precisely because there’s some possibility of catastrophe that this kind of bluffing is worthwhile. Furthermore, the risk of catastrophe is increasing over time, as e.g. Greek citizens start transferring their deposits to non-Greek banks. Nor does the claim that Tsipras’s threat “is not very credible” sit well with the argument that it might make sense for Germany to pay up. If the threat is non-credible, Germany simply has to sit back and call Tsipras’ bluff. This said, if Matt is overly sanguine, the pattern of bluff and counter-bluff suggests that Tyler Cowen is wrong to think that the politics make any deal impossible. If there weren’t any possible resolution, there wouldn’t be any incentive to engage in crisis bargaining. What we’re seeing suggests that the players on both sides think that there is a real chance of catastrophe, but also a real chance of a deal.

At a guess, Greece has considerably more bargaining leverage than it might seem to at first. One useful index of bargaining strength is relative levels of sensitivity to breakdown/catastrophe/failure to reach a deal. It’s plausible that Greece is relatively indifferent to breakdown at this point – years of grinding austerity inside EMU seem barely preferable to the costs of exiting the euro. In contrast, Germany could see the collapse of the euro (and consequent very serious economic costs) if a Greek exit leads to the collapse of confidence in Spanish, Irish, and worst of all, Italian banks. If I were to lay a bet on which side is likely to fold first, I’d be putting my money on the Germans.

18 Responses to Greece, brinkmanship and the euro, again

  1. Kevin Donoghue May 19, 2012 at 4:32 am #

    Henry,
    I’m sure you’ve seen Kevin O’Rourke’s post on this (link below) but maybe worth flagging for your readers.

    To some extent ISTM that the Greeks are in such a mess that it’s easier for them to find the right (i.e. least bad) move, as in a lousy chess position where all the ‘natural’ moves lead to defeat, but you can create hideous complications which just might produce a blunder from your opponent. In a game of chicken the guy who despairs of life is less likely to swerve.

    http://www.irisheconomy.ie/index.php/2012/05/17/irrational-greeks/

  2. dsquared May 19, 2012 at 9:58 am #

    Sorry if this ends up sounding a bit aggressive, but I’m finally blowing up and releasing steam that’s been building all week. Basically, I wish that people saying things like:

    “years of grinding austerity inside EMU seem barely preferable to the costs of exiting the euro”

    would think about it for a minute and maybe even do a few calculations. Firstly, it is not exactly an either/or scenario. EMU exit will require years of grinding austerity anyway. Second, the direct consequences of EMU exit are close to 20-30% of GDP, so even if Greece were to miraculously get an Argentinian rate of growth, it would take five years to get back to where they were. This calculation isn’t even nearly balanced.

  3. otto May 19, 2012 at 10:21 am #

    The distributional costs within Greece are likely to be different in the two cases, of course. At a first cut, the currently unemployed may be better off exiting and being able to price themselves into work by a devaluation, while those on more or less fixed Euro-incomes (yes I know there have been cuts) like public sector workers would probably be relatively better off staying in.

  4. Henry Farrell May 19, 2012 at 1:42 pm #

    I was wondering whether your grumpy Twitter comment was aimed at this post. Fair enough – but is there a substantial difference from the perspective of the Greek politicians negotiating (i.e. will they take a big political hit from Grexit)? I still think that the downside risks for Greek politicians of potentially leaving the euro are outweighed by the risk to German politicians of trying to deal with a collapsing euro.

  5. bert May 19, 2012 at 2:24 pm #

    I was just listening to friend Gideon Rachman’s weekly podcast.
    Down the line from Athens, Kerin Hope observed that Greek voters have been told so many times by so many different people that a given course of action would lead directly to economic collapse that they’ve begun to tune out arguments like dsquared’s. So, the calculation may point only in one direction, but that may not affect how eagerly brinkmanship is now embraced as a tactic.

    Instead, we shouldn’t be too surprised that people are choosing to listen to Syriza’s offer to have the cake and eat it. Let’s have euro membership, without the hardship of the current Troika programme. Obviously a lot can happen over the next four weeks, but I think there’s plenty of reasons to agree with Henry’s final paragraph above. My sense is that the German view has hardened around the wish to have Greece outside the euro, but there is still an enormous fear of contagion from a grexit in the immediate short term. The situation is volatile, and could easily be altered, most obviously by large and sustained bank runs in Greece or Spain, but right now the eurozone core buying a bit of extra time to delay the reckoning seems like the likeliest immediate outcome.

  6. Tracy Lightcap May 19, 2012 at 7:21 pm #

    A lot of the problem could be solved if Merkel would accept a higher inflation rate in Germany and get the ECB to go along with it. It’s unlikely that there is any political upside to the Germans offering or the Greeks accepting more bailout cash. That’s a recipe for a Greece = Iceland scenario, like dsquared says. Oth, a willingness to effectively devalue the DM and, by extension, the Euro, could be the kind of carrot that could get the GIPSIs to stay the course.
    Of course, there’s not much upside for that either. However, since every political party that’s in power now and pushing austerity will see their futures turn to dog vomit directly unless someone takes a risk, I’d use the recent Dutch and French government changes for cover and run with a new course. If I were Merkel, that is.

    • idiot May 20, 2012 at 2:12 pm #

      “However, since every political party that’s in power now and pushing austerity will see their futures turn to dog vomit”

      Except political parties that engage in austerity DON’T suffer electoral losses at home for supporting austerity (lower economic growth will probably lead to electoral problems though). Austerity does lead to social instability, but not actual electoral defeat.

      “The political economy literature on austerity suggests a paradox. There is no
      significant punishment at the polls for governments pursuing cut-backs
      (Alesina, Perotti, and Tavares 1998; Alesina, Carloni, and Lecce 2010), and no
      evidence of gains in response to budget expansion (Brender and A. Drazen
      2008). Also, the empirical evidence on the economic effects of budget cuts is
      mixed, with some studies finding an expansionary effect, and others, a
      contractionary one. Why, then, is fiscal consolidation often delayed, or only
      implemented half-heartedly?

      This paper suggests one possible reason why austerity measures are
      often avoided – fear of instability and unrest.”
      Source: http://www.voxeu.org/sites/default/files/file/DP8513.pdf

      As for seeing futures turn to dog vomit, that may be true, but only because you don’t specify the timeframe. If you take a long enough time frame, every party’s futures will turn to dog vomit.

      • Tracy Lightcap May 20, 2012 at 3:02 pm #

        “Except political parties that engage in austerity DON’T suffer electoral losses at home for supporting austerity (lower economic growth will probably lead to electoral problems though). Austerity does lead to social instability, but not actual electoral defeat.”

        The difference between us is that austerity has, in fact, already led to lower economic growth (indeed, to negative growth in Greece, Spain, UK) and continuing stagnation. That has and will lead to major political problems going forward on both the stability and electoral side (see Greece, France, Netherlands for this). I also think that, unless the EU makes a change in policy towards growth, the potential for a continent-wide double-dip will increase. So the dog vomit transformation might take place fairly quickly.

        Thanks for the citation, however, I hadn’t made the connections to this line of research and I should have. Now I’ll have to do some re-calibration.

        Btw, in the post I fell victim to an analogy I use to explain the EMS to students. I tell them to look at the subscriptions of Eurozone countries to the ECB, then think of the Euro as a DM that other countries have accepted. So what I should have said was that if the Germans were willing to press the ECB to slack up on their short range inflation targets (I think the treaties would allow that) then there would be a chance to save the Euro without more (direct) bailouts. My bad: once again, I wrote at haste and paid for it.

    • Itsthespending May 21, 2012 at 3:26 pm #

      Germany is currently funding the deficit accounts for the rest of the EU. A low & stable inflation rate permits that to continue. If inflation rises things will get out of control quickly. So, what is next for the central planners? The Bundesbank may be open to more ECB influence and monetization. German taxpayers are not going to like that.

  7. dsquared May 22, 2012 at 3:41 am #

    I still think that the downside risks for Greek politicians of potentially leaving the euro are outweighed by the risk to German politicians of trying to deal with a collapsing euro

    I agree with this – it’s the quantitative stuff about Greece that has me going crazy (actually that tweet wasn’t about Greece at all – to an extent all my raving about this subject is a proxy war against the real enemy – the No campaign in Ireland, for whom the calculus of advantages is just laughably obvious). Am currently arguing with Kindred Winecoff on this.

    Basically the reason that brinkmanship works in Greece’s favour is that Greece is small and the cost to Germany of just paying them to shut up is so small that even a small risk that they’ll do something catastrophically stupid is worth paying them off to avoid. Greece’s advantages don’t rest on any assessment of the facts in which it could even nearly be in their interests to exit – just on the risk of the Greek politicians being backed into a corner by their electorate (also, the Greek negotiators have the advantage of being able to point to changeable politics back home). Spain or Italy wouldn’t have anything like as many cards to play in the same game because the cost of keeping them onside would be less trivial.

  8. Fall in Queue May 22, 2012 at 8:02 am #

    @dsquared:

    Firstly, it is not exactly an either/or scenario. EMU exit will require years of grinding austerity anyway.

    This is clearly correct, but arguably it works in the other direction too. For Greece, it seems likely that “staying the course” does not mean staying in the EMU. It just means facing default and possible EMU exit after a few more years of grinding austerity. If that’s right, then it’s no longer so obvious that forcing a roll of the dice now is irrational for Greece.

    On a different note, I will be voting in Greece on June 17th, for the first time in 12 years. (I’ve been living in the US and Australia in the meantime.) Is there any chance you can do another Choose Your Own Adventure, but from the perspective of a Greek voter this time?

  9. Majorajam May 22, 2012 at 10:40 am #

    Sorry, but this all overlooks that Greek governance is as replete with agency issues as ever, and Germans have no truck for free riders (that’s about as deeply engrained a social norm as exists in that culture). Of the two, the former is the more deadly force. Tsipiras doesn’t care about Greece, let alone Greek citizens. He cares about Tsipiras. I suppose you could argue that’s not uncommon amongst politicians, but Tsipiras ‘corruption in the time of demagogues’ takes it to a whole different level.

    Witness his knowingly peddling pipe dreams about memoranda-less bailouts, which the a majority of a desperate electorate have come to believe. Were Tsipiras to be able to assemble a winning coalition in the next election, which I very much doubt, (and which is not likely to be part of the plan anyway, given that power at this point would expose him), he would not be able to take any concessions from Germany that Germany would be remotely willing to offer. That would only open the door for the next demagogue with yet fewer scruples (there’s never want for rank opportunists when the chips are down).

    The way I see it, the next round of elections will be the last that see any former mainstream parties in the government; their coup de gras. When the next government’s fig leaf of small concessions from Germany gets blown away by the reality of a deepening depression, the fragile coalition government will not last, and Tsipiras will be there to pick up the pieces. At that point, the German hard liners will have all the pretext they need to withhold bailout funds and Tsipiras will have all the pretext he needs to claim that Europe is the problem. Greece will have no choice but to leave the euro and calamity will ensue in the eurozone.

    I know some are out there claiming that Greece could stay in the euro without bailout funds or support from euro institutions, but this ignores the fact that the Greek banks won’t survive the removal of ECB backstop liquidity, whether or not they are recapitalized before the event, whether or not the official sector writes off Greek government and central bank debts, whether or not existing bailout funds are used to cover Greek PSI bond interest payments, whether or not global growth accelerates and whether or not capital controls are put in place.

    No bailout means extraordinarily harsh austerity in a time where animal spirits have been obliterated. Powerful debt deflation will consume the economy, and that will be that. Both Greece and Europe need to decide and to go all in, because such half-measures represent the worst of both worlds.

  10. dsquared May 22, 2012 at 11:40 am #

    It just means facing default and possible EMU exit after a few more years of grinding austerity

    The trouble is that what we now call “grinding austerity” would be viewed as “the good old days” from the viewpoint of post-EMU-exit Greece. Default within the Euro is just so much better a solution than “defaultandeuroexit”. As far as I can see, the IMF at least is actually saying in writing that the memorandum needs to be renegotiated, and the rest of the troika are very likely to come round once they have some idea of who is on the other side of the table. This is a much more manageable situation than people think.

    And in any case, uncertainty increases the “value of waiting” – by not taking irreversible actions you preserve the option value. If Greece decides to stay in the Euro, and then at some future date this looks like the wrong idea, they can change their mind. If they leave the Euro and regret it, they can’t change it back.

  11. bert May 22, 2012 at 7:45 pm #

    This is a much more manageable situation than people think.

    In the short term, perhaps. It requires another salami slice of cash, and for disbelief to be suspended once again.
    Can I check if I understand you right? Assuming that a sustainable primary balance can be achieved, you’re suggesting default (sparing the IMF, perhaps) as Greece’s best course? Or should they look to stay in the programme, provided they can negotiate more congenial terms?

  12. Fall in Queue May 22, 2012 at 8:50 pm #

    Bert, the idea that Greece will be running a budget surplus of around 4-5% for several years while the economy is in free-fall is clearly fantastical. What can’t happen won’t happen. So default or some sort of renegotiation of the debt to the official sector will take place now or later. But we should be clear here that “renegotiation”, like “private sector involvement”, is just a euphemism for default.

    The question is how we get there from here, and what happens then. I think dsquared is right that the worst option for everyone (and especially Greece) would be for Greece to pull an Argentina or to be forced out.

    What I’m still not sure is whether it is a mistake on Greece’s part to force a roll of the dice now, rather than wait until it becomes impossible to deny that it can’t hit its targets. The risk of a diplomatic and political clusterfuck leading to exit and meltdown seems to me likely to increase rather than decrease the longer we wait.

  13. bert May 22, 2012 at 9:40 pm #

    I think the gap between German largesse and Greek ability to deliver is wider than dsquared suggests. He wasn’t keen on PSI. I’m wondering how much OSI will be needed to keep the show on the road. And how far down the road that’ll take us.
    Have you chosen who you’ll vote for, FiQ?
    A real wealth of confidence-inspiring choices.

  14. Itsthespending May 22, 2012 at 11:13 pm #

    Greece has defaulted atleast 5 times since 1800. This is number 6. What else is there to call their situation? Their economy will never grow enough to sustain. Asking to pay debts, too? Leaving the Euro just keeps getting worse the longer they wait. I believe a hard landing followed by a people who will adjust better than we think regardless of what is decided. The majority of Greeks want to stay, but with more bailout money and less stipulations. The real trouble is the mass exodus to follow, beginning with Spain.

    Euro bank stocks are lower now than in 2008 during the Lehman debacle. The BRIC’s are contracting. China is now talking their own stimulus. If we are talking rolling the dice, something seldom heard is Germany telling everyone in Europe to stick it, we are done. They already said that, for now, regarding Euro bonds and rightfully so. Fall in Queue is right, the longer this takes the worse it will be. No winners here.

  15. Itsthespending May 23, 2012 at 8:50 am #

    From Reuters this AM:

    http://www.reuters.com/article/2012/05/23/us-eurozone-greece-idUSBRE84M0P420120523

    The game of chicken is going to end with the IMF, not the EU since it will be falling apart, supporting Greece with its exit. When you read IMF your really reading US taxpayers.